3.1.2 Business growth

Question 1

Why do businesses want to grow?

Answer 1

Firms usually grow to increase their profit, which can be achieved by:
- Increasing economies of scale
- Increasing market share and reducing competition
- Expanding into new markets

However, firms may also want to grow due to:
- Product diversification
- Status of running a large firm
- Easier access to finance

Question 2

Circumstances encouraging business growth

Answer 2

• A gap in the market created by changing consumer tastes and technology.
• Finance - Business growth can be financed by a parent company (cross-subsidisation).
• If barriers of entry can be put in place by a firm. For example, if a firm can secure a patent quickly.
• If a firm was able to ‘make the first move’, then economies of scale create a barrier to entry.

Question 3

Circumstances preventing business growth

Answer 3

• Poor management
• Lack of finances to meet demand
• Small market without the ability to reach economies of scale
• Nature of the business means that small, close customer
  service is more effective – inability to ‘scale-up’ the business.
• CMA may block a takeover or merger.

Question 4

Organic growth (and an example)

Answer 4

Where a firm’s market share is increased by reinvesting profits, innovation, improving productivity and launching products into new markets.

For example, increasing output by building a larger factory, hiring more workers, and increasing the amount of raw materials used.

Question 5

Advantages of organic growth

Answer 5

• The firm has control over exactly how this growth occurs.
• Can be financed by retained profits.
• Builds upon a business’ strengths.
• Allows the business to grow at a more sustainable rate.
• More likely to be able to monitor and avoid the principal-agent problem.

Question 6

Disadvantages of organic growth

Answer 6

• Tends to be slow.
• Can be more expensive.
• Growth achieved may be dependent on the growth of the overall market.
• Harder to build market share if business is already a leader.
• Slow growth – cannot progress without retained profit or borrowing.
• Rivals may opt for M&As and grow more quickly … could even buy your firm!

Question 7

Inorganic growth

Answer 7

Where a firm’s market share is increased as a result of takeovers and mergers.

Instead of trying to defeat rival firms, inorganic growth involves purchasing rivals. Although competition authorities (such as the CMA) can block mergers and acquisitions.

Question 8

Takeover

Answer 8

When one firm buys another firm, which becomes part of the first firm.

Question 9

Merger

Answer 9

When two firms unite to form a new company.

Question 10

Advantages of inorganic growth

Answer 10

• Quicker than organic growth.
• Cheaper than organic growth.
• Easy way to gain experience and expertise in a new area of business.

Question 11

Disadvantage of inorganic growth

Answer 11

Competition authorities (such as the CMA) can block mergers and acquisitions.

Question 12

Horizontal integration

Answer 12

Mergers take place between companies at the same stage of the production chain.

Question 13

Advantages of horizontal integration

Answer 13

• Larger market share
• Larger base of customers
• Increased revenue
• Reduced competition
• Increasing synergies
• Economies of scale
• Reduced production costs

Question 14

Disadvantages of horizontal integration

Answer 14

• Reduced economic growth
• Regulatory scrutiny

Question 15

Real-life examples of Horizontal Integration

Answer 15

• Disney purchased Pixar (both animation studios).
• Morrisons and Safeway in 2004 (both supermarkets).
• Nike and Umbro (both sports brands).
• Iberia and British Airways (both airlines).
• Orange and T-Mobile (both phone network providers).

Question 16

Vertical integration

Answer 16

Firm merges with another company that is involved in a different stage of the production process.

Question 17

Forwards vertical integration

Answer 17

When a firm takes over another firm that is further forward in the production process (closer to the consumer). E.g. Cadbury buying a chocolate shop.

Question 18

Backwards vertical integration

Answer 18

When a firm takes over another firm that is further back in the production process (closer to the raw materials). E.g. Cadbury buying a cocoa farm.

Question 19

Advantages of vertical integration

Answer 19

• Economies of scale
• Expands geographically
• Efficiency
• Differentiate from competitors
• Securing a supply chain

Question 20

Disadvantages of vertical integration

Answer 20

• Established distribution channels may be affected
• Could lead to a monopsony

Question 21

Real-life example of vertical integration

Answer 21

Apple purchased a chip-manufacturing company (backwards) and opening up retail stores (forwards).

Question 22

Conglomerate merger

Answer 22

Firms from different industries merge. E.g. Ford and a dairy farm.

Conglomerate mergers allow firms to diversify and spread their risk – if one part of the new firm does badly, this can be compensated for by profit from another part of the firm.
A conglomerate merger will also allow a firm to use profits generated by one product to invest in another.

Question 23

Advantages of conglomerate merger

Answer 23

• Gain synergies
• Diversification
• Improves customer base
• Economies of scale

Question 24

Disadvantages of conglomerate merger

Answer 24

• No past experience
• Shift in focus
• Diseconomies of scale

Question 25

Real-life examples of conglomerate merger

Answer 25

- Amazon purchased Whole Foods (a US supermarket company). - Virgin – with Media, Airlines, Banking - Co-operative group – with Food, Banking, Funerals - Unilever

Question 26

Disadvantages of growth

Answer 26

- If two firms merge there will be a duplication of staff, such as marketing, finance and HR. It’s therefore likely that some of this staff will be made redundant. - The merged firms may have different or incompatible objectives that will need to be resolved - A firm can put itself in a lot of debt in order to raise the finance necessary to complete a takeover. - The new, larger firm may suffer from diseconomies of scale.

Question 27

Benefits of business growth on consumers

Answer 27

- A larger firm may benefit from economies of scale which could lead to price reductions for consumers. - The combined creativity of two firms working together may lead to the production of better quality products.

Question 28

Negatives of business growth on consumers

Answer 28

- Consumers will have less choice if two or more firms merge. - The reduction in competition caused by firms merging may also lead to higher prices for consumers. - Two merged firms may produce less output than two separate firms, which will lead to price increases.

Question 29

How do governments monitor mergers?

Answer 29

Typically via a competition authority (the CMA in the UK). For example, a merger can lead to the creation of a monopoly, which will have advantages and disadvantages for consumers. If a government decides that a merger is unfair to consumers, then it can take action to block the merger.

Question 30

Reasons for mergers/takeovers

Answer 30

- Increase market share - Spread risk - Lower costs of production (through economies of scale) - Eliminate competition - To acquire tangible (e.g. infrastructure) and intangible (e.g patents) assets - To acquire a new customer base - Quick expansion of firm - Access to new market - Overcoming barriers to entry - Increase profits - To create synergies

Question 31

Tangible assets

Answer 31

Physical assets e.g. Labour, machines, buildings

Question 32

Intangible assets

Answer 32

Not physical assets. E.g. Distribution rights, trademarks and patents.

Question 33

Synergy

Answer 33

“Whole is greater than the sum of its parts”. - When workers, firms and other economic agents work together effectively, synergy is created. This leads to innovation and higher productivity (than if they were apart). | If a merger is successful, it can bring synergy to both firms.